In my presentation on “Creativity in the Investment Process,” I have a slide of an empty two-dimensional box (OK, it’s just a poorly-drawn square). The box has a label, which is soon revealed:
As I say, “This is the box that we are in.”
We have come to view “consistent and repeatable process” as the Holy Grail of investment manager selection. The phrase has become the descriptive standard most used by those who evaluate managers, so that if you interact with consultants or financial advisors, you are bound to hear it frequently.
It’s nice in theory, but there’s a big gap between theory and practice. First off, process is way messier in most cases than those diagrams of process in pitch books and on websites would have you believe. Which parts, specifically, are consistent? How are they repeatable? What kind of sludge tends to get into the gears of the finely-honed machine, even if we don’t notice it much of the time?
Furthermore, the phrase is thrown around a lot by folks who don’t really know the details and nuances of the process in question, but know the marketing version of it. In essence, they see patterns of performance and infer process of a certain consistency and repeatability. Therefore, it’s helpful to think of a confidence level of sorts; does sufficient evidence really exist to deem something as “consistent and repeatable”? It’s a high hurdle to jump.
But, worse than that, it’s the wrong goal.
Because this isn’t stamping out widgets, it’s investing in markets. A process must be evolutionary when appropriate and constantly focused on improvement when it is available for the taking. Not change for change sake, but thoughtful change when it makes sense.
Who could argue with that? Yet many investment organizations are afraid to change for fear of appearing to be inconsistent or of marring the sheen of repeatability that has attracted clients.
Sometimes, they do decide to change a bit but their message remains the same. And so, a gap develops. Or they resolutely refuse to change and the market evolves without them. Then a different kind of gap develops. In either case, trouble lurks down the road.
To be clear, when I write that “the market evolves without them,” I don’t mean that a manager should abandon its valuation discipline, for example, when the market gets beyond its comfort level. I’m referring to situations in which a previously successful strategy has come up against long-term forces that are likely to inhibit its success in the future. Or — to return to the theme of my creativity talk — that the structural approach and informational strategies that worked in yesterday’s world are unlikely to work in tomorrow’s.
Consider, if you will, the differences in how people tend to evaluate quantitative versus fundamental managers. In the quantitative realm, it is no surprise that certain kinds of signals and factors become less powerful over time, as the market does its thing. Trying to improve the model is part of the equation, so “consistent and repeatable” includes an ethos of research into methods, experimentation, and constant evolution.
But on the fundamental side of the business, those activities are viewed with suspicion. “Consistent and repeatable” has come to mean little research into methods, little experimentation, and little or no evolution unless things just aren’t working (for a prolonged period of time) — for the price of change is the disruption of the marketing force field that relies on the status quo.
The Holy Grail ought to be a process that is as consistent as is reasonable given the circumstances and as repeatable as is credible given the realities of markets, but it must be evolutionary, focused on improvement over stasis. That means bucking the selection standard identified by many gatekeepers — and effectively communicating with those gatekeepers and the asset owners that they represent about why they should not expect anything less.